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WASHINGTON — Federal Reserve Chairman Ben Bernanke painted a dark picture of where the U.S. economy is headed if Congress fails to reach agreement soon to avert a budget crisis.

"It would probably knock the recovery back into a recession and cost a lot of jobs, and would greatly delay the recovery that we're hoping to facilitate," said Bernanke at the end of two hours of testimony Tuesday before the Senate Banking Committee.

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But Bernanke said lawmakers must go beyond the year-end issues and come up with on a plan to shrink the budget deficit. Otherwise, the United States could suffer a financial crisis marked by rising interest rates.

"We might face ... a financial crisis where interest rates would rise, as we're seeing now in Europe and that would feed through to other interest rates like mortgages and other kinds of rates. And it would be very costly to our economy," he said.

Bernanke was giving his midyear report on the state of the economy. And that wasn't pretty either. It's growing modestly but has weakened in recent months, he said. Job growth has slumped, manufacturing has weakened and consumers have lost confidence and have cut back on spending.

The Fed is prepared to take further action if growth doesn't improve. Bernanke provided no clues about what steps the Fed might take or whether any action was imminent.

But Bernanke noted that there is only so much the Fed can do

If Congress doesn't take action by the end of the year, a package of tax cuts adopted during George W. Bush's administration expire while deep spending cuts kick in. If that happens, the economy would go over a "fiscal cliff."

Congress would help the economy by resolving the issue well before the year ends. "Doing so would help reduce uncertainty and boost household and business confidence," he said.

An election-year standoff has immobilized Congress. Republicans want deeper spending cuts while extending the Bush-era tax cuts for all income classes. Democrats want to extend the tax cuts for middle- and lower-class Americans, while allowing them to expire for those in the higher-income brackets.

Bernanke stopped short of telling Congress how to proceed. He challenged them to think broadly.

Investors had hoped Bernanke would signal another round of bond purchases, to drive down long-term interest rates and encourage more borrowing and spending. But they seemed to shrug off the downbeat outlook and focused on stronger earnings reported by Mattel, Coca-Cola and other big companies.

At least one senator implored Bernanke to take action now.

"Given the political realities of this year's election, I believe the Fed is the only game in town," Sen. Charles Schumer, a New York Democrat, said. "I would urge you, now more than ever, to take whatever actions are warranted."

"So get to work, Mr. Chairman," Schumer added.

Even if the Fed announces another round of bond purchases, some economists question how much that would help. They note that mortgage rates and other key interest rates are already at record-low levels.

The economy was already sputtering when the Fed's policymaking committee last met June 19-20. At that meeting, the Fed decided to extend a program that shifts its bond portfolio to try to lower long-term interest rates. The Fed also reiterated its plan to keep its key short-term interest rate near zero until at least late 2014.

Minutes of the June meeting show that Fed officials were open to taking further action — but were divided over whether the economy needs help now.

Since then, the government has reported that job growth slowed sharply in the April-June quarter — to 75,000 a month from 226,000 a month from January through March. The unemployment rate stayed at 8.2 percent in last month.

Former Fed official Roberto Perli, managing director at the research firm International Strategy & Investment, doubts the Fed will take action at its next meeting July 31-Aug. 1, preferring to wait for more evidence of where the economy is headed.

But if growth and job creation continue to weaken, he says, Fed policymakers might unveil another round of bond purchases at its Sept. 12-13 meeting.

Readers' Comments (1)

According to USA today, Bernanke said to the Senate Banking Committee that if Congress didn't reach a compromise, a "fiscal cliff" could occur. That is, the combination of tax increases and spending cuts that are scheduled to begin at the end of the year could inhibit economic growth. "The reduction in the unemployment rate seems likely to be frustratingly slow," and "Congress is in charge here, not the Federal Reserve," he said. [source: http://www.usatoday.com/money/... /> This is a serious warning to Congress to not delay action on the issue of taxation. As a matter of fact, taxation is the most critical issue when creating a feasible federal budget. The reason is simple logic: the budget is based on the total predicted government revenue, and most of the government revenue comes from taxation. Due to the increasing government revenue, the Obama Administration will be able to provide more stimulus plans to boost the economy. As soon as the economy is boosted, unemployment will be reduced, and millionaires will enjoy the increases in their income as well as their safety from crimes. It's indeed a feasible economic solution for the agenda of balancing the budget and gradually paying off the debt. The Obama Administration will be able to provide more stimulus plans to boost the economy. Moreover, Obama's tax plan prevents the dangerous scenario of Congress's austerity agenda. The IMF's Christine Lagarde, the World Bank's Robert Zoellick, and the WTO's Pascal Lamy have the same economic viewpoint: Focus on policies which strengthen growth, employment, and the quality of life in every part of the world.Extreme austerity leads to a lack of demand and hence less supply; consequently more unemployment and slow growth. Austerity also means less quality of life. The economic austerity in Greece is a good lesson. Recently in Europe, spending is now preferred to austerity. The greatest concern of austerity is a reversal of the current trend of economic recovery, which could result in an economic "Armageddon". Nevertheless increasing government spending will avoid such a possible "Armageddon".